Educational Articles

Revaluing the Yuan: Floating in a Dream

Reuben Gregg Brewer
| June 21, 2010

On June 19th, the People’s Bank of China announced that it would further reform the exchange rate controls it has in place for the yuan. That news sent stock markets around the globe higher in early trading today. The news is, indeed, welcome, but it is likely more of a long-term benefit than one that will be felt today.

If history is any guide, China isn’t making this announcement because its leaders think it will benefit other nations. The country has proven adept at fighting the suggestions of others until China believes it is in its best interest to act. And, more often than not, the change is on their terms (as any change a country makes should be) and not on the terms suggested by the world.

Indeed, the wording of the release suggests as much. “…the People’s Bank of China has decided to proceed further with reform of the RMB [yuan] exchange rate regime and to enhance the RMB exchange rate flexibility.” That is a far cry from saying that the yuan is on the verge of floating freely. Moreover, the statement goes on to say, “…the basis for large-scale appreciation of the RMB exchange rate does not exist.” That pretty much puts the final nail in the coffin of a floating yuan anytime in the near future.

So, while global markets have taken this change in high spirits, bidding up stock prices worldwide, it seems a bit premature to think that anything material has changed. That isn’t to say that the news is bad, it may very well turn out to be a major positive. But it isn’t likely to be a wonderful thing as quickly as many seem to hope.

China has made great strides over the years, moving from a stagnant, centrally-planned economy to one that is more free. Note the word “more” in that sentence. The economy is still centrally planned and Chinese society is still heavily monitored and regulated. This isn’t the type of nation that is likely to just let currency controls go away overnight. If anything, this is going to be a process.

In fact, the news about a free-floating yuan isn’t really new, China has been making slow progress toward this end for several years now. The process started some five years ago, or so, and has been moving forward since, including a change in the exchange rate peg in 2008. The fact that the yuan would float, eventually, has been something of a given to many. The only issue was the question of when. It isn’t clear that the recent news answers that question.

There is also the possibility that this announcement is more political than functional. With a major economic meeting of world leaders (the so-called G8 and G20 meetings) coming up in a few days, this announcement will clearly steal some thunder from world leaders who have been decrying the yuan’s peg to the dollar, including many in the United States. Depriving the currency manipulation conversation of its substance is a clear benefit to China. Indeed, this rhetoric has grown more fierce as China’s economy has grown rapidly while others have labored along at a slow and uneven pace coming out of the worldwide recession that began in late 2007.

In the end, this is positive news, but not news about which to get overly excited. China is almost always conservative with its currency. Expecting anything else this time around is likely a mistake.